Wednesday, February 01, 2006


Where does it give?

I have been devoting a lot of time lately to trying to figure out what direction the economy will take. I'm not an ideologue, I am not trying to sell people on gold, and I hate catastrophe mongering. I want to figure out how I-- and other members of the reality-based community-- can get through the next years in reasonable comfort. For me, that's especially difficult because I don't want to make money from destructive mining, the oil majors, or war. Figuring out how the coming economic debacle will unfold is extraordinarily difficult. The basic problem is... well, besides Republicans in general... the oversupply of US dollars, which has three consequences: (1) it distorts asset prices, especially inside the United States but also abroad, and (2) if financed by government or private borrowing, it requires debt service that subtracts from future prosperity, and (3) if financed by asset sales, it reduced the capacity of the economy to generate wealth for the benefit of citizens. But economics is not so simple. In World War II, we ran massive deficits (roughly $200B, equivalent in its burden on the economy to something like $10T today) without inflation because the debt was held by Americans willing to forego current consumption. When they ceased to be willing to be patient, there was inflation. Fortunately the US had its productive base intact, had suffered proportionately fewer casualties than other combatants, and was in a position to dominate world trade for decades to come. Losers of wars suffer far more wrenching dislocations. Inflation is one means by which an oversupply of dollars can be addressed. The number of dollars stay the same, but the purchasing power declines. Other means include: * adjusting the currency downward, reducing the purchasing power of dollars, * tax and pay down governmental debt, * increase interest rates. This reduces the purchasing power of borrowers. It also has perverse effects: increasing the incomes of lenders, reducing national growth rates, and potentially causing inflation in industries where capital is an important factor of production. The Bush Administration increased the debt by $2.1 Trillion from September 2001 to September 2005. However, this is the unified budget in which Social Security surpluses mask even larger deficits, some obligations seem to have been incurred off the books, and of course the people who have paid into Social Security and Medicare are going to want to receive the services they paid for. Household debt is at historic levels (though corporate debt is down). Also, unlike World War II, we will not emerge from the conflict in a dominant economic position, but in a prone one. So, how will we get... uh... well, you know? Here's a comment by Robert Brusca, chief economist at FAO worth reading. Greenspan saw the economy expend a lot of its resources to get the results he presided over. Now it is time to pay the piper. For what you ask? Here are some of the excesses that facilitated growth and cannot be repeated: (1) ramping up fiscal deficits, (2) growing the international deficit to the brink that has created crises in lesser countries, (3) letting other countries peg to the dollar while these excesses built, (3a) letting foreign exchange reserves abroad build to the level of ridiculousness, (4) consumers using the equity in their homes to support other spending, (5) consumer debt running up because interest rates are so low (conundrumesque?) that they seemingly 'can afford more debt', (6) housing prices running up without any guidance to banks on lending, fueling the 'bubble'. Those surplus dollars are pouring out into gold and foreign stocks in a non-sustainable fashion. Real estate has risen in an unsustainable fashion, not simply because the absolute prices of homes are too high, but because substantial rises in the costs of heating and commuting could make them unaffordable. And, of course, the dollar is way overvalued. So, there are several ways this could play out: * as a severe global recession, in which the shock is distributed over the whole system, * as a severe adjustment of the dollar, effectively decoupling the rest of the world from the major shock, but foreshadowing a moderate global recession, * as a crash in asset prices (i.e., homes) in the US, leading to a severe domestic recession, * as very high levels of inflation in the US, leading to a slower decline in the dollar, * most likely, as a combination of the above. But what combination? My guess is that the rest of the world is not going to take one for the Gipper (global recession). So, * they are likely to find means to "print money," though at a less scandalous rate than Bush. This will reduce the severity of the domestic outcome, but lead to elevated global inflation. * they are likely to cut off further investment in the US, probably causing the US dollar to drop by about one-third. This will have the effect of reducing the government debt to pre-Bush levels. Imports, almost certainly including oil, will cost much more. * as a result of rising import prices, inflation will rise. US policymakers will raise interest rates (my guess is that they will hit 10% on 10-year corporate), and growth will fall. * asset prices will then collapse. There's no guarantee that even gold will have any special value, since you can't eat it. The very rich, especially including foreigners will buy those assets. Everyone else will be reduced to the status of serfs. On the other hand, there is a fairly simple alternative. Collect the taxes the rich avoided by installing Bush in office, with a surcharge for starting an unnecessary war, and use that to pay down the debt. By localizing the pain among those very few, the US could emerge... not whole, but at least with some modicum of dignity. And contrary to Republican claims, I believe many of them would much rather suffer that pain than the pain of being remembered as the generation that destroyed America.
Scarily enough, Greenspan's replacement is known as "Helicopter Ben" for his half-joking statement that we should print lots more money and drop it on people to solve all our problems. So don't expect him to deal with inflation until it's too late.
Oh, don't listen to that static. Bernanke is a moderating voice on a Fed that is way too hawkish on inflation.

The problem is that there are very strong inflationary pressures and massive deficits. So, if the Fed jacks up rates, it creates a fiscal crisis both by raising the cost of servicing the debt and by cutting already anemic average growth and therefore the capacity of taxes to pay in.

If nominated for Fed Chairman, I would not run. If elected, I would not serve. The situation is that bad, and if Bernanke comes out of it with his reputation intact, he'll be a hero on par with Keynes.
This is off topic but I want to start a movement to make the Democratic Party leadership draft Sheila Jackson Lee as a party spokesman and point person. She is better than any of the ones they've been putting up. She is excellent.

Please consider this, bloggers.
Thanks, Charles. I'd heard that Bernanke might well be one of the few Bush appointees that isn't a hack and a carpetbagger. But that article had caused me to have second doubts.

It sounds as if Bush may have, purely by accident, picked someone who a) knows what he's doing and b) has our best interests at heart. (Shhhhh! We don't want Bush trying to replace him!)
EPT: I'm still trying to wrap my mind around the idea of Cryin' Dick Durbin as a Senate "whip".
EPT, I thought long and hard about this and decided you're right. I haven't always felt that Congresswoman Lee was genuine (more below), but maybe I judge her by too high a standard.

Sheila Jackson Lee occupies some size 98 shoes, those of the late Barbara Jordan. Barbara Jordan not only lifted herself up by her bootstraps, she hunted down the lion from which she made those boots by hand. It's a no excuses district.

And Jackson Lee has done some important things. She was one of the 13 who objected to Bush's installation in 2000. She has made it no secret that she thinks Bush stole 2004 and said so before the Conyers Commission. She signed on with other Judiciary Democrats to call Bush to account over NSA spying.

My concerns are summed up in two moments. In the 2003(?) SOTU, she rushed up and hugged Bush. Now, in Texas, this is the way things are done. People are Texans first, ladies or gentlemen second, Methodists/Baptists/Catholics/Nazarenes third, Republicans or Democrats fourth, and Americans fifth. But Barbara Jordan would have simply shaken Mr. Bush's hand. Assuming he offered it first.

The second was when Cindy Sheehan set up Camp Casey. The Congresswoman was on vacation. At first, it was no big deal. But the minute the police moved Sheehan and the other protestors into the ditch, Congresswoman Lee should have been out the door, down the drive, and in fourth gear. *Everyone* remembered: this is what the police did to the Freedom Marchers. In the August heat, it's not only harassment, it's dangerous.

Well, long story short, despite those doubts, I'm in. Give us the plan. What position should she be appointed to, and who needs to be phoned or written to?
Bernanke probably won't last six months, and I figure he will just be the first in a long string of no-accounts that prove useless against the monstrous deficits the Republicans have laid, like flaming blivets, at the doorsteps of us all.

I do not even trust American cash, nor government bonds. World markets will likely outperform most American assets over the next few decades.

It's probably safe to invest in your local banks and energy companies, but Russia, China, India, Europe, and even the southeast Asian "tigers" are likely to outperform the western hemisphere as a whole.

But then again, I raise koi in the Sonoran desert, so please take what I say with the appropriate portion of
fleur de sel.
I bet those are some thirsty fish, shrimplate. I would have tried for a pond or a lake, myself.

The American market would have melted down but for one unfortunate fact: every other market has its problems. Europe with slow growth and high unemployment, Asia with tsunamis, earthquakes, and what is euphemistically called "lack of transparency," Latin America with corruption and political instability (mostly due to the US, but that's another story), and so on.

And then there's this problem that unless you have beaucoup bucks, you can only invest through mutual funds or their newest incarnation, exchange traded funds. They don't really tell you what you're investing in. You could be financing a chain of underage brothels, as long as it fell below ca. 3% of holdings. Most of them are the same large cap companies. And they sting you on fees and other hidden charges.

Someone I know looked at things in the Bush recession of 1990, decided there was no financial future and bought land with the intent of being completely independent. Made sense at the time. Lost everything.

The US market had a long track record of doing well over the long haul. But it has gone sideways for 5 years so people are getting antsy. Problem is, a lot of foreign markets have run a long way and are going to run out of steam at some point.
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